Over the last decade, and in the wake of one of the most devastating economic downturns in the last century, a new form of investing emerged, crowdsourcing. Crowdsourcing, as the name implies, involves dozens, hundreds or even thousands of investors pouring small amounts into a single investment opportunity. Utilizing a crowd of eager investors is a huge advantage for potential entrepreneurs who may otherwise be stifled by the elite venture capital (VC) firms who determine their investments more on the “who” rather than the “what.”

Traditionally, VC firms are the stepping stone between early-stage entrepreneurs who need quick capital and larger investors and other corporations who seek a more diversified and risk-averse investment portfolio. Utilization of a VC firm allows the startup to acquire relatively large amounts of capital which, both allow the startup to flourish and conduct normal day-to-day operations while reporting to a select few investors. However, VC investment tends to come off as more of the relationship between parties than a typical investment. Due to the typically large capital influx accompanying the enormous risk, VC firms will place their members on the boards of their investments. Or, at a minimum, conduct routine meetings with the startup to ensure the company is thriving while guiding or pushing the company to take certain business decisions that will secure the investment further.

However, the traditional routine of rounds of VC investments face a new upstart in the field, crowdsourcing. There are four stereotypical models of crowdsourcing which startups look to from various online facilitators such as GoFundMe and Kickstarter. The first two models, discussed only briefly, are the reward system and donation model. Though enticing to one time, layperson investors, the reward system is, in a sense, pre-order sales. An investor puts money towards a startup’s concept and is rewarded by a copy of the item or service—potentially at a discounted rate—before the rest of the purchasing public. This method may provide some additional funding, however, for most startups, creates a sizeable liability in the way of pledged rewards.

Similarly, the donation model, found routinely on GoFundMe, is not the pathway for investors. As the name implies, the donation model relies on large amounts of individuals charitably donating small amounts towards a company, entity, or cause. For example, consider relief efforts after natural disasters.

In contrast, the ever-growing equity crowdsourcing model provides a new pathway for low-level investors to get involved on the ground floor while entrepreneurs maintain the majority of business decisions. Following the Obama administration’s passage of the JOBS Act in 2013, the SEC lifted its longtime ban on general solicitation for funding. Thus, through internet crowdsourcing sites such as Crowdfunder, investors who normally wouldn’t qualify as a high-value-investor for a VC firm may still participate. Under the Act, the individual investors must still be “accredited,” otherwise defined as earning over $200,000 in the previous two years or have a $1 million net worth outside of their primary residence. Though this restricted the every-man from investing a few dollars here and there, as witnessed in the reward model, the floor to investment was undoubtedly lowered. Lower-net worth citizens could finally get in on the ground floor and own a small part of an early-stage private company. Then, just two years later, Congress passed Title IV of the Act which allowed for non-accredited investors to join accredited ones in investment rounds of up to $50 million.  In 2015 alone startups and other established firms received an estimated $34 billion in crowdsourced investments. As the industry continues to allow for more individual involvement, the crowds will grow. Those crowds will bring with them a larger pool of capital and lead to more start-ups receiving the funds they so desperately desire.

Tagged with: , ,

Posted in: Business Law, Corporate Transactions